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Just the other day the Federal Reserve decided to drop interest rates by 75 basis points. This surprise rate cut came as a response to the large dip in world markets while the US markets were closed for Martin Luther King Day. The rate cut also comes at a convenient time for banks trying to sort out their subprime situation. Many subprime borrowers were enticed into taking out loans with low initial monthly payments. When their rates adjusted their loan payments doubled in some cases. This has caused many financial institutions to write off millions and billions of dollars of bad debts. The rate cut was intended to help out many of those institutions that are in dire need of assistance.

There has been such a big deal made of this rate cut because it was unexpected. Typically rate changes are announced during one of the Fed’s planned meetings. This one occurred out of the blue. The Fed will be meeting again on January 29th and 30th. Many analysts expect that the Fed will cut rates once again to help out our struggling economy.

These rate cuts should help to stimulate our economy because they appear to help out more people than they hurt. With lower rates, subprime borrowers should see the monthly payments on their adjustable loans drop. This should help to slow down the number of foreclosures. With these rate cuts loan refinancing should become big again. Lower rates will also make the cost of owning a home less for buyers, so the housing market should start to turn around as well.

Rate cuts do have a negative impact on some people. Many retired people rely mainly on fixed income securities like CDs to provide them money to live off of. As rates decrease, their interest earned on these CDs decreases as well.

Every day at work I come across a new situation that needs to be handled a bit differently. Today was no exception. I had a mom come in who had for this example about $5,000 in a 14 month CD paying approximately 4.75%. The maturity of the CD was in August, so she was about halfway through the term of the CD. She also had about $1,800 saved up in a money market account. For the purpose of this example, let us assume that the trip costs a flat $5,000. Let us also assume that the funds in the money market are needed for every day household expenditures, so they could not be used to pay for the trip. She told me that her daughter was going to be traveling abroad for a few months this summer, so she was going to need some extra money to finance it and was thinking about making an early withdrawl from her CD to cover the costs. At my financial institution, as well as the large majority of others, fees are charged for early withdrawls on CD accounts. Here, we charge 180 days of interest for withdrawls no matter when they are taken out.

I told the member that if she were to make an early withdrawl, then we would have to assess a 180 day interest penalty. She wasn’t too keen on that idea, so we started searching for ways around this. Initially I thought that she could take out a personal loan to finance the trip, but even at the lowest rates they are still in the 7 - 8% range for a good credit borrower. If she took out a loan at that rate she would be paying more in interest on the loan than she would be receiving on the funds that are still in the CD. In this situation, it would make more sense to just liquidate the CD, pay the early withdrawl fee, and then use those funds to pay for the trip. Although she would lose out on 180 days of interest, she would be able to pay off the trip in full and not have to worry about any debt. She would also save money by not having to pay that higher interest rate.

After talking to her a little more, I came to find out that she had a promotional rate credit card where the rate was only 2 - 3% through the end of 2008. Since the rate she is paying on this card is less than what she is earning, it would make sense for her to keep the CD open and finance the trip through the credit card. What worked out even better for this member was that the trip did not have to be paid for until April. This means that she could put the entire trip on the card, make the minimum payments for the next few months, and then pay the card off with the funds from the matured CD. At this point, the card will be entirely paid off before that high interest rate kicks in.

This example is a great way to take advantage of a low introductory rate on a credit card. Just be sure you know when those high rates start up and have your card fully paid off by then!